On February 21, 2018, the Securities and Exchange Commission (SEC) approved an interpretive release updating guidance on public company disclosure and other obligations concerning cybersecurity matters. The interpretive release, titled “Commission Statement and Guidance on Public Company Cybersecurity Disclosures,” Release No. 33-10459 (Guidance), had been scheduled to be considered at an open meeting on February 21, which was canceled. Much of the Guidance is devoted to reiterating and expanding upon the Division of Corporation Finance's 2011 CF Disclosure Guidance: Topic No. 2, Cybersecurity, which was issued to assist companies in assessing what disclosures might be required about cybersecurity risks or incidents. WilmerHale discussed the 2011 guidance here. Emphasizing the increasing significance of cybersecurity incidents in recent years, the new Guidance further illustrates potential disclosures that companies should consider and comments on matters beyond disclosure obligations. The Guidance stresses the importance of cybersecurity policies and procedures, and discusses the application of disclosure controls and procedures, insider trading prohibitions, and Regulation FD selective disclosure prohibitions. Recognizing that the cybersecurity landscape continues to shift, Chairman Clayton commented in a separate statement that the Commission “will continue to evaluate developments in this area and consider feedback about whether any further guidance or rules are needed.”
While the Commission action on the Guidance was unanimous, the two Democrats on the Commission, Commissioners Stein and Jackson, each released a separate statement indicating their disappointment that the Commission had not gone further in the Guidance. Commissioner Stein listed a number of additional steps the SEC could have taken, including through notice and comment rulemaking on potential new requirements related to board risk management frameworks for cyber risks, minimum standards to protect the personally identifiable information of investors, Form 8-K reporting of cyberattacks, and development and implementation of cybersecurity-related policies and procedures beyond just disclosure. These and other ideas included in Commissioner Stein's statement open an interesting window on discussions that likely have been taking place among the SEC Commissioners and staff over the past months as they have worked to update the 2011 staff guidance and elevate cybersecurity to the Commission level.
General Disclosure Guidance
The Guidance summarizes the basic disclosure requirements applicable to registration statements under the Securities Act of 1933 and the Securities Exchange Act of 1934 (Exchange Act), as well as to periodic and current reports under the Exchange Act. Noting that Regulation S-K and Regulation S-X do not explicitly reference cybersecurity risks and incidents, the Guidance makes clear that a number of these disclosure requirements nevertheless impose an obligation to disclose such risks and incidents depending on a company's particular circumstances.
Tailored Disclosures and Materiality. As in the 2011 CF Disclosure Guidance, the new Guidance counsels against companies providing generic cybersecurity-related disclosures. The Commission continues to recognize that companies are not required to include disclosures that would provide a “roadmap” for how to breach a company's security protections. As noted in the Guidance, companies are not expected to “publicly disclose specific, technical information about their cybersecurity systems, the related networks and devices, or potential system vulnerabilities in such detail as would make such systems, networks, and devices more susceptible to a cybersecurity incident.”
A central tenet of tailored disclosure is a company's materiality determination. The Guidance notes that in evaluating materiality in the context of cybersecurity matters, “companies generally weigh, among other things, the potential materiality of any identified risk and, in the case of incidents, the importance of any compromised information and of the impact of the incident on the company's operations.” Other relevant considerations include the potential magnitude of the cybersecurity risk or incident, particularly where data may be compromised, and the range of harm that could be caused. Examples of harms highlighted in the Guidance include harm to the “company's reputation, financial performance, and customer and vendor relationships, as well as the possibility of litigation or regulatory investigations or actions, including regulatory actions by state and federal governmental authorities and non-U.S. authorities.”
Disclosure Timing. The discussion of the timing of disclosure of cybersecurity matters in the Guidance illustrates how difficult this question can be. The Guidance acknowledges that when companies experience cybersecurity incidents they may require some time to understand the scope of the incident and thus to determine whether disclosure is required. The Guidance also notes, however, that “an ongoing internal or external investigation – which often can be lengthy – would not on its own provide a basis for avoiding disclosures of a material cybersecurity incident.”
The Guidance reminds companies to be watchful for situations where they need to correct prior disclosure, either where such disclosure was untrue when made or if it omitted a material fact necessary to make the disclosure not misleading. In addition to describing this well-recognized “duty to correct” prior disclosures that were materially inaccurate or omitted material facts when made, the Guidance includes a brief reference to a potential “duty to update” disclosures regarding cybersecurity matters that become materially inaccurate after they are made, “for example, when the original statement is still being relied upon by reasonable investors.” The question of whether there actually is a “duty to update” under the federal securities laws is indirectly addressed in an accompanying footnote, which cites to conflicting case law on the question of whether such a duty exists. Through this discussion, the Commission has raised the possibility that companies may need to update cybersecurity disclosures, but has also acknowledged that this may not be required under the federal securities laws.
Specific Disclosure Considerations
The Guidance highlights specific disclosure areas to which companies should pay particular attention. As summarized below, the Guidance identifies a number of considerations companies should weigh in determining whether and to what extent disclosure may be required.
Risk Factors. Pointing to the requirements under Item 503(c) of Regulation S-K, the Guidance notes that cybersecurity risks should be disclosed if those risks are among the “most significant factors that make investments in the company's securities speculative or risky.” In drafting such disclosure, companies are encouraged to consider the following issues:
- the occurrence of prior cybersecurity incidents, including their severity and frequency;
- the probability of the occurrence and potential magnitude of cybersecurity incidents;
- the adequacy of preventative actions taken to reduce cybersecurity risks and the associated costs, including, if appropriate, discussing the limits of the company's ability to prevent or mitigate certain cybersecurity risks;
- the aspects of the company's business and operations that give rise to material cybersecurity risks and the potential costs and consequences of such risks, including industry-specific risks and third-party supplier and service provider risks;
- the costs associated with maintaining cybersecurity protections, including, if applicable, insurance coverage relating to cybersecurity incidents or payments to service providers;
- the potential for reputational harm;
- existing or pending laws and regulations that may affect the requirements to which companies are subject relating to cybersecurity and the associated costs to companies; and
- litigation, regulatory investigation, and remediation costs associated with cybersecurity incidents.
In addition, companies “may need to disclose previous or ongoing cybersecurity incidents or other past events in order to place discussions of these risks in the appropriate context.” This includes considering incidents that may affect the company directly, or that may have affected suppliers, customers, competitors and others.
MD&A. As it relates to a company's disclosure of events, trends and uncertainties under Item 303 of Regulation S-K, the Guidance notes that companies should consider “the cost of ongoing cybersecurity efforts (including enhancements to existing efforts), the costs and other consequences of cybersecurity incidents, and the risks of potential cybersecurity incidents, among other matters.” Other potential costs that companies should consider include:
- loss of intellectual property;
- immediate costs of the incident;
- costs associated with implementing preventative measures;
- maintaining insurance;
- responding to litigation and regulatory investigations;
- preparing for and complying with proposed or current legislation;
- engaging in remediation efforts;
- addressing harm to reputation; and
- loss of competitive advantage that may result.
Business. The Guidance advises that appropriate disclosure must be provided regarding a company's description of its business under Item 101 of Regulation S-K, particularly where “cybersecurity incidents or risks materially affect a company's products, services, relationships with customers or suppliers, or competitive conditions.”
Legal Proceedings. With respect to disclosure of material pending legal proceedings under Item 103 of Regulation S-K, the Guidance notes that cybersecurity issues could give rise to a disclosure obligation. As an example, the Guidance suggests that material litigation by customers against a company for the theft of customer information should be described in response to this disclosure requirement.
Financial Statements. Illustrating the impact that cybersecurity incidents could have on a company's financial statements, the Guidance states the Commission's expectation “that a company's financial reporting and control systems would be designed to provide reasonable assurance that information about the range and magnitude of the financial impacts of a cybersecurity incident would be incorporated into its financial statements on a timely basis as the information becomes available.”
Board Risk Oversight. With respect to required disclosures about how a company's board administers its risk oversight function under Item 407(h) of Regulation S-K and Item 7 of Schedule 14A, the Guidance indicates that such disclosure should include a discussion of the board's role in overseeing the management of cybersecurity risks where such risks are material to a company's business. As part of this disclosure, the Guidance encourages companies to include a discussion about how the board interacts with management on cybersecurity issues.
Policies and Procedures
Disclosure Controls and Procedures. As a “key element” of enterprise-wide risk management, the Guidance “encourages” companies to “adopt comprehensive policies and procedures related to cybersecurity and to assess their compliance regularly, including the sufficiency of their disclosure controls and procedures as they relate to cybersecurity disclosure.” Sufficient disclosure controls and procedures should be designed to (a) ensure that relevant information about cybersecurity risks and incidents is processed and reported to the appropriate personnel and (b) facilitate policies and procedures intended to prohibit corporate insiders from trading on the basis of material nonpublic information about cybersecurity risks and incidents.
According to the Guidance, disclosure controls and procedures should focus on more than specific, required disclosures and should be structured to timely collect and evaluate information that could be subject to required disclosure or that could be relevant to an assessment regarding whether a need exists to provide disclosure. The Guidance states that certifications by a company's principal executive officer and principal financial officer about the design and effectiveness of disclosure controls and procedures and their conclusions about the effectiveness of such disclosure controls and procedures should “take into account the adequacy of controls and procedures for identifying cybersecurity risks and incidents and for assessing and analyzing their impact.”
Insider Trading. The Guidance reminds that “[c]ompanies and their directors, officers, and other corporate insiders should be mindful of complying with the laws related to insider trading in connection with information about cybersecurity risks and incidents, including vulnerabilities and breaches.” The Guidance explains the Commission's view that because certain cybersecurity risks and incidents may involve material nonpublic information, “directors, officers, and other corporate insiders would violate the antifraud provisions if they trade the company's securities in breach of their duty of trust or confidence while in possession of that material nonpublic information.”
According to the Guidance, because insider trading risks could result from weak controls around cybersecurity risks and incidents, companies are encouraged to have in place policies and procedures to prevent trading on the basis of all types of material nonpublic information, including cybersecurity risks and incidents. When a cybersecurity incident occurs, or when a company is investigating such an incident, the Guidance advises that consideration should be given as to whether restrictions on insider trading should be put in place. The Guidance suggests that “companies would be well served by considering how to avoid the appearance of improper trading during the period following an incident and prior to the dissemination of disclosure.”
Regulation FD and Selective Disclosure. The Guidance also cautions companies and persons acting on their behalf to keep in mind Regulation FD and not to make selective disclosures of material nonpublic information regarding cybersecurity risks and incidents until such information has been publicly disseminated. The Commission expects that companies have in place policies and procedures to ensure that such selective disclosures are not made and that any Regulation FD-required disclosure be made either simultaneously (for intentional disclosures) or promptly (for non-intentional disclosures).
Next Steps by the SEC
Chairman Clayton's statement indicates that the SEC and its staff will consider disclosures made following the issuance of the Guidance in determining whether additional Commission action is needed, including possibly rulemaking on the topic. Chairman Clayton's statement indicates that cybersecurity disclosure will be “carefully monitored” as part of the staff's selective filing reviews. In light of the continuing interest in additional specific requirements with respect to cybersecurity matters expressed by two of the SEC Commissioners and public interest in the topic generally, cybersecurity likely will remain a potential area for future rulemaking.
Next Steps for Companies
The Guidance will be effective on publication in the Federal Register. However, since the Guidance expresses the Commission's current interpretations of existing rules, companies and their advisers should take it into account now.
The timing of the issuance of the Guidance – just as many calendar-year-end companies have already filed, or at least completed the preparation of their Form 10-Ks – makes it unlikely that it will meaningfully impact this year's Form 10-Ks. This should not raise concerns since the interpretations regarding periodic disclosures about cybersecurity matters are largely consistent with the existing staff guidance from 2011. The Guidance should be considered for future periodic reports, including the Form 10-Q for the March 31 quarter.
Going forward, companies that have not yet prepared their proxy statement disclosures should review and consider refreshing their disclosures regarding oversight of cybersecurity risks in light of the specific discussion of Item 407(h) of Regulation S-K. Also, boards should consider how oversight of cybersecurity risk is accomplished by the board and update protocols as necessary in light of current circumstances.
Companies should also review their disclosure controls and procedures to make sure they capture cybersecurity matters for consideration of possible disclosure. Existing insider trading policies and Regulation FD policies should already cover any type of material nonpublic information, including cybersecurity matters, so it likely is not necessary to revise these policies, although cybersecurity incidents could be added to lists of examples of potentially material information included in these policies. Also, those who determine whether trading windows should be closed or specific trades should be approved, or whether a particular disclosure would be compliant with Regulation FD, should be mindful of developing cybersecurity issues and consider the Commission's Guidance.